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carlos_andres24 de Julio de 2013

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Bruner, R.F. (2001). Diamond Chemicals PLC (A):the Merseyside Project. ReRecuperatee la base de datos

de Darden Business Publishing (UV2493) (027341)

AM.

DARDEN UV2493

BUSINESS PUBLISHING Version 1.5

UNIvERsrry9,VIRGINIA

DIAMOND CHEMICALS PLC (A):

THE MERSEYSIDE PROJECT

Late one afternoon in January 2001, Frank Greystock told Lucy Morris, "No one seems satisfied with the analysis so far, but the suggested changes could kill the project. If solid projects like this can't swim past the corporate piranhas, the company will never modernize."

Morris was plant manager of Diamond Chemicals' Merseyside Works in Liverpool, England. Her controller, Frank Greystock, was discussing a capital project that Morris wanted to propose to senior management. The project consisted of a (British pounds) £9-million expenditure to renovate and rationalize the polypropylene production line at the Merseyside plant in order to make up for deferred maintenance and to exploit opportunities to achieve increased production efficiency.

Diamond Chemicals was under pressure from investors to improve its financial performance because of both the worldwide economic slowdown and the accumulation of the firm's common shares by a well-known corporate raider, Sir David Benjamin. Earnings per share had fallen to £30.00 at the end of 2000 from around £60.00 at the end of 1999. Morris thus believed that the time was ripe to obtain funding from corporate headquarters for a modernization program for the Merseyside Works—at least she had believed so until Greystock presented her with several questions that had only recently surfaced.

Diamond Chemicals and Polypropylene

Diamond Chemicals, a major competitor in the worldwide chemicals industry, was a leading producer of polypropylene, a polymer used in an extremely wide variety of products (ranging from medical products to packaging film, carpet fibers, and automobile components) and known for its strength and malleability. Polypropylene was essentially priced as a commodity.

This case was prepared by Robert F. Bruner as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Diamond Chemicals is a fictional company reflecting the issues facing actual firms. The author wishes to acknowledge the helpful comments of Dr. Frank H. McTigue, the literary color of Anthony Trollope, and the financial support of the Citicorp Global Scholars Program. Copyright CD 2001 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation.

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The production of polypropylene pellets at Merseyside began with propylene, a refined gas received in tank cars. Propylene was purchased from four refineries in England that produced it in the course of refining crude oil into gasoline, In the first stage of the production process, polymerization, the propylene gas was combined with a diluent (or solvent) in a large pressure vessel. In a catalytic reaction, the polypropylene precipitated to the bottom of the tank and was then concentrated in a centrifuge.

The second stage of the production process compounded the basic polypropylene with stabilizers, modifiers, fillers, and pigments to achieve the desired attributes for a particular customer. The finished plastic was extruded into pellets for shipment to the customer.

The Merseyside production process was old, semicontinuous at best, and, therefore, higher in labor content than its competitors' newer plants. The Merseyside plant was constructed in 1967.

Diamond Chemicals produced polypropylene at Merseyside and in Rotterdam, Holland. The two plants were of identical scale, age, and design. The managers of both plants reported to James Fawn, executive vice president and manager of the Intermediate Chemicals Group (ICG) of Diamond Chemicals. The company positioned itself as a supplier to customers in Europe and the Middle East. The strategic-analysis staff estimated that, in addition to numerous small producers, seven major competitors manufactured polypropylene in Diamond Chemicals' marketregion. Their plants operated at various cost levels. Exhibit I presents a comparison of plant sizes and indexed costs,

The Proposed Capital Program

Morris had assumed responsibility for the Merseyside Works only 12 months previously, following a rapid rise from the entry position of shift engineer nine years before. When she assumed responsibility, she undertook a detailed review of the operations and discovered significant opportunities for improvement in polypropylene production. Some of those opportunities stemmed from the deferral of maintenance over the preceding five years. In an effort to enhance the operating results of the Works, the previous manager had limited capital expenditures to only the most essential. Now, what previously had been routine and deferrable was becoming essential. Other opportunities stemmed from correcting the antiquated plant design in ways that would save energy and improve the process flow: (1) relocating and modernizing tank-car unloading areas, which would enable the process flow to be streamlined; (2) refurbishing the polymerization tank to achieve higher pressures and thus greater throughput; and (3) renovating the compounding plant to increase extrusion throughput and obtain energy savings.

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Morris proposed an expenditure of £9 million on this program. The entire polymerization line would need to be shut down for 45 days, however, and because the Rotterdam plant was operating near capacity, Merseyside's customers would buy from competitors. Greystock believed the loss of customers would not be permanent. The benefits would be a lower energy requirement' as well as a 7% greater manufacturing throughput. In addition, the project was expected to improve gross margin (before depreciation and energy savings) from 11.5% to 12.5%. The engineering group at Merseyside was highly confident that the efficiencies would be realized,

Merseyside currently produced 250,000 metric tons of polypropylene pellets a year. Currently, the price of polypropylene averaged £541 per ton for Diamond Chemicals' product mix. The tax rate required in capital-expenditure analyses was 30%. Greystock discovered that any plant facilities to be replaced had been completely depreciated. New assets could be depreciated on an accelerated basis' over 15 years, the expected life of the assets. The increased throughput would necessitate a. one-time increase of work-in-process inventory equal in value to 3.0% of cost of goods. Greystock included in the first year of his forecast preliminary engineering costs of £500,000, which had been spent over the preceding nine months on efficiency and design studies of the renovation. Finally, the corporate manual stipulated that overhead costs be reflected in project analyses at the rate of 3.5% times the book value of assets acquired in the prof ect per year.'

Greystock had produced the discounted-cash-flow (DCF) summary given in Exhibit 2. It suggested that the capital program would easily hurdle Diamond Chemicals' required return of 10% for engineering projects.

Greystock characterized the energy savings as a percentage of sales and assumed that the savings would be equal to 1.25% of sales hi the first 5 years and 0.75% in years 6-10. Thereafter, without added aggressive "green" spending, the energy efficiency of the plant would revert to its old level, and the savings would be zero. He believed that the decision to make further environmentally oriented investments was a separate choice (and one that should be made much later) and, therefore, that to include such benefits (of a presumably later investment decision) in the project being considered today would be inappropriate.

2 The company's capital-expenditure manual suggested the use of double-declining-balance (DDB) depreciation, even though other more aggressive procedures might be permitted by the tax code. The reason for this policy was to discourage jockeying for corporate approvals based on tax provisions that could apply differently for different projects and divisions. Prior to senior-management's approval, the controller's staff would present an independent analysis of special tax effects that might apply. Division managers, however, were discouraged from relying heavily on those effects. In applying the DDB approach to a 15-year project, the formula for accelerated depreciation was used for the first 10 years, after which depreciation was calculated on a straight-line basis. This conversion to straight line was commonly done so that the asset would depreciate fully within its economic life.

3 The corporate-policy manual stated that new projects should be able to sustain a reasonable proportion of corporate overhead expense. Projects that were so marginal as to be unable to sustain those expenses and also meet the other criteria of investment attractiveness should not be undertaken. Thus, all new capital projects should reflect an annual pretax charge amounting to 3.5% of the value of the initial asset investment for the project.

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Concerns of the Transport Division

Diamond Chemicals owned the tank cars with which Merseyside received propylene gas from four petroleum refineries

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